Sellers who decide that they wish to sell their business have a choice of options over which a Purchaser may or may not be able to exert influence. Sellers can either choose to sell the assets of their business or, more commonly, they can sell their shares in the company which owns those assets. The purchase of an established business is likely to be a very involved process. At the outset, Purchasers need to prepare themselves to deal with a substantial amount of detailed and lengthy documentation. A significant amount of the Purchaser’s management time is also likely to be taken up, although establishing good reporting structures and lines of communication with all its professional advisors at an early stage, will reap benefits later.
Whether or not the Purchaser’s solicitors get involved with negotiating the transaction will depend very much upon the relationship they have with the Purchaser, or whether the Purchaser has an independent financial advisor. In any event, the Purchaser’s solicitors will benefit from being involved in a transaction from as early as possible, simply because the deal may otherwise incorporate terms which are difficult, if not impossible, to perform for legal reasons. In those circumstances, the deal will inevitably have to be re-negotiated at a later stage.
2. Heads of Agreement
The main terms of a transaction are sometimes set out in a Heads of Agreement. These can be useful and will usually be binding to a certain extent, leaving time for other elements of the deal to be negotiated. The binding obligations could well be not to negotiate with any third party during a particular period, to allow the Purchaser full access for investigation, and to negotiate in good faith with a view to achieving completion by a particular date. Purchasers sometimes like Heads of Agreement to be executed, even if non-binding, since this is regarded as the moral commitment by the Sellers to sell the target company, and thus justifies the Purchaser’s expense of proceeding with its initial investigations.
3. Due Diligence
In the vast majority of cases, the main purpose of the transaction is the acquisition of the underlying business of the target company, and its continuation as a successful going concern. To do this, the Purchaser will want to satisfy itself that it has made a thorough enquiry into the financial aspects of the business, its profitability (or the reasons for its lack of profitability) and the prospects for the future of the business. It will want to ensure that the business can be carried on, should it so wish, in the same manner as it was by the Sellers, once it is under its control.
The type and extent of any due diligence investigations which the Purchaser makes will depend entirely upon the nature of the business. The Purchaser will want to investigate any problems relating to the target company. This will involve, for example, litigious or potentially litigious aspects such as alleged infringement of the intellectual property rights of others, disputes concerning defective products, product liability or disputes with former employees, to name but a few.
The Purchaser’s solicitors will become involved either directly or peripherally with the Purchaser’s other professional advisers in all the matters which a Purchaser will need to consider, including not only the corporate aspects, but also those of a property, taxation, pensions and employment nature. It will be the responsibility of the Purchaser’s solicitors to co-ordinate the various steps in the transaction, and to bring it to completion.
The Purchaser’s offer to purchase the shares of a target company is likely to be based upon its own knowledge of the target company, discussion with the directors of the target company and, at the initial stages, probably not much more than a review of the audited accounts and (possibly) the management accounts. The Purchaser is unlikely to be familiar with the detail of the target company’s business. If the Purchaser’s solicitors are able to point out from the results of their investigations areas of particular concern, this may cause the Purchaser to revise its offer or, alternatively, to reconsider whether it wants to buy the target company at all.
From the Purchaser’s solicitors’ viewpoint, the due diligence enquires enable them to decide whether or not there are any matters revealed by the answers to those enquiries which merit particular attention in the warranties or indemnities (which ultimately make up a large portion of the main Sale and Purchase Agreement).
4. Accountants’ Report
The Purchaser will usually commission a report from its accountants in order to provide an expert independent assessment of a target company and its activities. Assuming that the Purchaser is a company, the Board of the Purchaser will be looking for comfort that their opinion of the target company is not misguided, and that the target company should make a good fit with the existing companies and operations of the acquiring group. The accountants will look at the audited accounts and management accounts, together with the target company’s and its auditor’s working papers.
5. Structure of Purchase Price
There are four main ways in which the Purchaser can structure the payment of the purchase price:
- Cash: In most instances, the decision to pay cash is the most straightforward option. There can, however, be problems as a result of the financial assistance provisions of the Companies Act 2006, which must be considered in certain scenarios.
- Earn-out: Where it is important to the Purchaser that some of all of the Sellers stay on after completion, it is common to base the price payable partly on the future trading results of the target company. This has the benefit that the Sellers do not suddenly change their minds about agreeing to stay on once they have received the payments for the sale of their shares. The price payable will normally be a mixture of a lump sum payment on completion, followed by payments made in later years, based upon the profitability of the target company, calculated by reference to set a formula agreed prior to completion, and contained in the Sale and Purchase Agreement.
- Loan Stock: Loan stock is an instrument issued by the Purchaser acknowledging indebtedness to the Sellers. It is a matter for negotiation when the loan stock is to be redeemable for cash, and what interest rate the loan stock will bear. The use of loan stock can be very useful to Sellers in mitigating their capital gains tax liability.
- Shares: Shares in the Purchaser are often used to satisfy the purchase price. This is particularly so where the Purchaser is quoted on the Stock Exchange. Thus, the Sellers exchange their shares in the target company for shares in the purchasing company, which they can later sell on the Stock Exchange. This has the obvious attraction from the Purchaser’s point of view that it does not actually have to produce any cash. It simply allots shares to the Sellers, and when those Sellers want to realise their shares for cash, they simply sell the shares on the open market.
6. Completion and Post-Completion
The Purchaser will need to ensure the legal transfer of the shares in the target company and deal with the commercial requirements in readiness for completion. The funding of the purchase price will need to be arranged with the Purchaser’s bankers (and/or stockbrokers in the case of a share exchange). Board authority for the acquisition needs to be obtained and mundane matters such as notifying insurers, employees and the press will also need to be dealt with.
Post-completion planning is an area which is often neglected. It is vital that a co-ordinator be appointed at a suitably senior level at the earliest opportunity, in order to implement the transition process. This is perhaps best dealt with by formulating a checklist of matters with agreed target dates and set responsibilities. The topics covered can range from operational activities such as agreeing and implementing a reporting structure, sales activities such as notifying customers, or financial matters such as implementing new purchasing controls. Monitoring the change-over in this way will lead to lessons being learned for future acquisitions.
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